To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Speaking of which, we noticed some great changes in ADF Group's (TSE:DRX) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for ADF Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.076 = CA$13m ÷ (CA$226m - CA$60m) (Based on the trailing twelve months to July 2022).
Thus, ADF Group has an ROCE of 7.6%. On its own that's a low return, but compared to the average of 4.3% generated by the Metals and Mining industry, it's much better.
See our latest analysis for ADF Group
Historical performance is a great place to start when researching a stock so above you can see the gauge for ADF Group's ROCE against it's prior returns. If you're interested in investigating ADF Group's past further, check out this free graph of past earnings, revenue and cash flow.
The Trend Of ROCE
Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The data shows that returns on capital have increased substantially over the last five years to 7.6%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 29%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
Our Take On ADF Group's ROCE
To sum it up, ADF Group has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Given the stock has declined 26% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. So researching this company further and determining whether or not these trends will continue seems justified.
One more thing, we've spotted 2 warning signs facing ADF Group that you might find interesting.
While ADF Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
About TSX:DRX
ADF Group
Engages in the design and engineering of connections including industrial coatings in Canada and the United States.
Outstanding track record with flawless balance sheet.
